The decision of government to hike customs duty on gold amid the continued call by the Reserve Bank of India to curb domestic gold usage and import of gold has provided hard-nosed traders and importers some more elbow room for speculation.
The move apparently has served as a trigger for importers to import more gold instead of discouraging them, some analysts say. Prices continue to go up in the retail segment, as wholesalers pass on any duty hike to consumers.
While RBI has mooted gold-backed investment instruments for investors to hedge against inflation as opposed to investing in physical gold, such investment options prove to be esoteric for the consumers, both to understand and access. A case in point is that the entire banking system till date has not been able to popularise retailing of government and corporate bonds even among informed customers, leave aside the semi urban and rural consumers who find solace by investing in gold for security purposes.
On the other hand, a trader with gold in the vault, the receipt of which could be used to vouch as an intent of delivery for settling futures trade, is managing 20-21 per cent annualised gain almost every year since 2010. The strategy seems to be selling in the spot market, buying February contracts and selling April contracts in gold. According to brokers in the market, the counterparties to these trades are usually known to each other. Eventually the receipts sold in the cash market come back to the same person when he settles the buy position of the February contract from the same party whom he sold in spot market earlier. However this trader, for his sell position in April, chooses not to wait till the delivery but squares it off just before the budget is announced by settling the trade in cash. Thus, he maintains his receipts with him and exits the market with the gain, brokers said.
Now, the objective of the government is to curb fiscal deficit by discouraging import of gold through quantitative fiscal restrictions, which has indeed served its purpose. India’s current account deficit grew from 2.7 per cent in 2010-11 to 4.2 per cent in 2011-12. During this period, gross official import of gold bullion rose from $38 billion to $54 billion. However as per a report of Thompson Reuters GFMS, jump in imports during the period is attributed to rising gold prices overseas and not due to increased volume of imports. In fact, net imports (excluding round tripping and genuine exports) weakened by 9 per cent and volume of gross imports actually declined by 6 per cent, according to GFMS data.
Incidentally, there have been numerous cases where gold is actually exported with value addition as jewellery but revenue intelligence has confirmed against the purity of such gold by the weight. In essence, the export is merely of rough cut metal. Why would one do that? The government has several incentives for gems and jewellery exports including tax benefits to entire units set up in special economic zones across the country extending up to 5-10 years. Besides, there are 180 days dollar credit limit for star exporters. According to revenue authorities, these exporter enjoy a huge arbitrage opportunity in securing the dollar borrowing as gold loan since they have to provide collateral for all such loans.
Usually the exporter maintains a five-year fixed deposit with a bank on which, as a high net worth individual, he enjoys 11-11.5 per cent interest. This fixed deposit is provided as collateral for securing the letter of credit for the gold export. The loan, on the other hand, is charged around 7-8 per cent, so the exporter enjoys an interest gain of 3.5-4.5 per cent and even more if the dollar borrowing benchmark - LIBOR goes down.
This arbitrage continues since the collateral remains the same for every six-month loan secured by the exporter.
On the other hand, the importer of this rough cut gold processes it in his country and sells. This also partly explains why since 2008, global jewellery is down by 30 per cent while exports from India have doubled, destinations remaining almost same during the period as per data from various gems and jewellery websites and analysts of gold.
Alternatives:
So if the government is serious about curing import of gold , there are various options to be considered and loopholes to be plugged
a) The market players are of the view that delivery-based future contracts propel gold imports, since there is a possibility of arbitrage. Though contracts are bought and sold on the basis LME benchmarks, the delivery is not always London good (which is a variety of gold benchmarked against Comex prices). Rather, delivery is done from Middle-East gold, which is cheaper than London good and thus offers arbitrage to the trader of around 40-50 cent per ounce. Therefore the settlement on exchanges should be made cash-based, like in crude contracts, said one of the traders.
b) For investment purpose, gold coins should only be sold by state trading corporations after being embossed and with other hallmarks for transparency of trade in gold in the domestic market.
c) The government should define what constitutes jewellery as there have been many controversies where export benefits outlined earlier are availed by exporters for exporting rough cuts rather than value added jewellery and thus to separate roundtripping of gold from genuine exports.
The financial market regulators should first make precise plans for aggressive marketing of gold-backed investment products like exchange traded funds and inflation indexed bonds, before taking harsh steps like duty hikes and banning banks from selling gold coins. This is because even if the consumer looks for investment options, there are none readily available nor comprehensible in lay man’s language. As per the current mindset of the common man, it is very difficult to substitute gold by gifting ETFs and bonds in marriage or temple offerings, for instance. Besides the procedure and operational costs of such investments are very high. The most critical part to be made clear to the retail is timely exit from the bond to cash which is even tricky for most bond traders in market.